Drought In the Panama Canal and Its Effects on Global Shipping

What You Need to Know About the Panama Canal

The Panama Canal is one of the world’s most important chokepoints as it typically accounts for 40 percent of United States container traffic and 5 percent of global maritime trade. It serves more than 180 maritime routes that connect at least 1,920 ports across 170 countries around the world.

Disruptions here therefore affect the global supply chain through delayed shipments, increased fuel usage, higher costs, significant GDP losses, and more.

The Panama Canal, which connects the Atlantic and Pacific Oceans, relies on freshwater from nearby lakes to operate its lock system. However, due to recent El Niño weather patterns and ongoing climate change, the region has experienced significantly reduced rainfall. This situation has led to lower water levels in the reservoirs of this artificial waterway, directly impacting its operations.

Panama Canal Authority, the Panama government agency responsible for the management of the Panama Canal, reported that the region experienced its third-driest year on record in 2023, with rainfall 30% below the historical average.

The ongoing crisis in the Red Sea is further compounding the impacts of shipping interruptions in the Panama Canal, resulting in severe ripples across the overseas shipping world.

The Red Sea crisis is a geopolitical conflict that involves Houthis, a Yemeni military group targeting commercial ships passing through the Suez Canal. The Suez Canal is the main maritime superhighway connecting Europe and Asia.

With both the Suez and Panama Canals becoming less reliable routes, commercial sea-going vessels are forced to take longer detours around the southern points of South America and Africa.

How The Drought in The Panama Canal Is Affecting Global Shipping

The Panama Canal Authority has restricted the number of ships passing through the canal for several dry months due to low water levels. Restrictions have also applied to the depth of the vessels allowed in the waterway, limiting the quantity of cargo they can carry.

But that is just the tip of the iceberg. Here is a detailed look at the ripples that this drought is having across the international shipping world.

Reduced Capacity and Longer Wait Times

The most immediate impact of the drought has been a significant reduction in the canal’s capacity in an attempt to conserve water. With less water available, the authorities are allowing fewer ships to transit the canal each day.

In 2022, the canal averaged 35 to 40 ships per day. Following the water reduction and subsequent Panama Canal Authority restrictions, the number dropped to 24 ships per day by late 2023. This represents approximately 36% reduction in the number of vessels crossing through the waterway.

Late 2023, specifically October, marked the driest of its kind on record for the Panama Canal Watershed. With the Panama Canal Authority anticipating a potential worsening of the situation, the agency decided to adjust the number of daily transits through the canal to 22 in December 2023, 20 in January 2024, and 18 in February.

However, January 2024 saw a slight increase in the number of vessels transiting the channel as rainfall and lake levels for the final months of 2023 proved to be less adverse than anticipated. Panama Canal increased its daily transits to 24 from January 2023, and 32 towards the end of the second quarter of the year.

Despite the slight improvements witnessed through the first half of the year, the canal’s current capacity is still a stark reduction from its initial capacity of 36 to 38 daily transits.

Such reduced capacities have created a bottleneck effect, with vessels sometimes waiting weeks for their turn to pass through. The delays are also creating a backlog of vessels waiting to pass through the canal. For time-sensitive cargo, these delays can be catastrophic.

Wait times increased from an average of 4 days to up to 22 days for some vessels. The Panama Canal Authority reported that wait times for non-booked vessels increased by between 44% and 59% towards the end of 2023, and has yet to return to its pre-drought averages of 4 to 5 days.

With increased wait times and the resulting congestion, many shipping companies have had to reevaluate their scheduling and logistics strategies, disrupting their operations.

Weight Restrictions and Partial Loads

In addition to limiting the number of ships passing through the waterway daily, the Panama Canal Authority has also imposed strict weight restrictions on vessels to conserve water.

The authority reduced the maximum draft (depth of a ship’s keel below the waterline) from 50 feet to 44 feet in some cases. This means many ships are now forced to carry partial loads or offload cargo before transit.

For context, each foot of draft reduction can mean a loss of up to 400 TEU capacity for a large container ship. This not only reduces efficiency but also increases costs for shipping companies, which are often passed on to consumers.  

Route Changes and Extended Voyages

Some shipping companies are opting to avoid the Panama Canal altogether as an alternative to waiting long periods in line or putting up with significant weight reductions. This alternative involves taking longer maritime routes circumnavigating South America, especially in the absence of a reliable Suez Canal.

While the longer routes keep goods moving, they significantly increase transit times and fuel consumption, which is reflected in increased crew wages and other operational costs.  

Rising Freight Rates

As a direct consequence of the Panama Canal situation, freight rates for routes typically using the Panama Canal have surged.

According to industry reports, spot rates for container shipments from Asia to the East Coast of the United States increased by up to 20% during peak drought periods. For instance, the rates reached approximately $7,114 per 40-foot equivalent container (FEU) towards the end of the second quarter of 2024. These higher freight costs can be attributed to supply chain disruptions and longer voyages.

Any such increase in shipping costs affects a wide range of industries. For example, U.S. grain exporters reported additional costs of up to $10 per ton for shipments to Asia, impacting their competitiveness in global markets.

Projected Long-term Economic Implications

If the drought conditions persist or worsen, we could see a reshaping of global trade routes with likely far-reaching economic implications.

The situation has prompted many businesses to reevaluate their supply chain strategies. Some companies may have considered nearshoring as an alternative to mitigate the impact of shipping delays that the water scarcity situation at the canal is causing. An analysis of global economic trends points in this direction.

Finding alternative suppliers closer to home could seem to reduce reliance on long-distance shipping, potentially accelerating trends toward nearshoring or reshoring. Trade data reflect this trend, with Mexico’s exports to the United States increasing by 5% in 2023, while those from distant places like China, Vietnam, India, and Taiwan falling by up 22% over the same period. This trend is likely partly attributed to companies seeking closer alternatives to Asian suppliers.

Meanwhile, the Panama Canal Authority is exploring long-term solutions, including the construction of new water reservoirs projected to cost about 1.6 billion US dollars. Considered alternatives also include a potential new sea-level canal. However, these projects would require significant investment and have their own environmental considerations.

Environmental Considerations

The issues associated with the drought-induced rerouting of ships are not purely economic in nature. While rerouting ships may solve immediate logistical problems, it comes at an environmental cost.

The longer journeys associated with rerouting mean increased fuel consumption and higher carbon emissions. These conflict with global efforts to reduce the shipping industry’s carbon footprint.

The Panama Canal route was projected to save over 160 million tons of CO2 emissions in approximately 10 years of operation. A large container ship rerouting around South America instead of passing through the Panama Canal can emit significantly more CO2 per journey, leading to a greater carbon footprint. 

The International Maritime Organization (IMO) estimates that shipping accounts for about 3% of global CO2 emissions, and this figure could rise if inefficient routes become more common.

How are shipping companies adapting to the drought in the Panama Canal?

The shipping industry is exploring various solutions in response to the drought in the Panama Canal. While we have captured some of these solutions in the discussion above, here is a quick summary of how shipping companies are adapting to the situation. 

·         Companies are exploring investment in more water-efficient ship designs, such as those with optimized hull shapes that can maintain capacity even with reduced drafts.

·         They are developing sophisticated route-optimization algorithms that factor in canal conditions, alternative routes, and fuel efficiency.

·         They are exploring the Northwest Passage as a potential alternative route, though this option comes with its own set of environmental and logistical challenges.

·         Some companies are even investigating the feasibility of ship-to-ship transfers near the canal entrances to optimize loads.

Wrap Up

Looking to the future, the Panama Canal situation highlights the need for significant infrastructure investments in the waterway installation to improve its water management and increase resilience to climate change.

The Panama Canal Authority is already working on solutions to its current woes, including a proposed $2 billion water management system to capture excess rainfall during wet seasons. Additionally, research is ongoing into the feasibility of desalination plants to supplement the canal’s freshwater supply.

It remains to be seen how these efforts bear fruit in the coming months or years.